The role of the reinsurance intermediary in the United Stateshas been tested in unprecedented ways in the last several years.Many of the challenges are the same as those affecting thefinancial services industry in general–increased competition,enhanced client service requirements, a focus on sophisticatedtechnical analysis and regulatory scrutiny.

There are also challenges that are unique to the reinsuranceintermediary–increased compensation transparency, the threat of adeclining reinsurance market and competition from the capitalmarkets. To meet these challenges brokers will need a platform thatadapts to the new environment.

Reinsurance intermediary services have, in general, a higherprofit margin than primary insurance broking. It is not unusual fora broker to earn $5 million in revenue for placing $1 billion ofproperty-catastrophe coverage for a single year, assuming a 10percent rate-on-line (ratio of premium-to- limit) and a standard 5percent brokerage rate.

The reason for the higher profit margin has been thatreinsurance is more complex than insurance, requiring a fairlylarge infrastructure of professionals to provide a high level ofservice and expertise to clients.

A system of accepted rates of brokerage, often referred tosimply with the term “standard brokerage,” has supported thisinfrastructure. For excess-of-loss placements, for example, thestandard brokerage rate is 5-to-10 percent of contract premium.

Calls for greater transparency have made clients more willing toquestion the appropriateness of standard brokerage. Is the amountof effort on the part of intermediaries, and the value that theyare adding, enough to justify standard brokerage?

Reinsurance brokers are also asking the same question. Forexample, on small accounts, standard brokerage may not be enough tocover the associated expense of placing the transaction.

Responding to the new environment, they are more inclined tojustify the cost of a placement based on expenses incurred andeconomic value added.

A recent analysis by Gallagher Re of publicly available U.S.statutory accounting information from 2001 to 2006 revealed that ina period where total gross premiums increased nearly 30 percent to$495 billion from $380 billion, the use of outsidereinsurance–measured by premiums ceded to nonaffiliatedcompanies–declined. Ceded premiums to nonaffiliates fell $6billion, or more than 8 percent, to $64 billion from $70 billion.(See NU, July 2/9, page 12, for more details.)

If current trends continue, brokers will face a decline in theircore business of traditional reinsurance placement and growingcompetition from the large and sophisticated capacity of thecapital markets. To meet these challenges reinsurance brokers willhave to take steps that directly address these issues:

o Broader Advisory Service Models

Reinsurance brokers will have to view themselves more broadly–asadvisors providing sophisticated risk management advice and accessto risk financing, where traditional reinsurance is one of manypossible financing vehicles.

A successful intermediary will have a proposition that offersexpert advice and knowledge through the pooled resources of itspeople, across a platform of various areas such as traditionalreinsurance, alternative products, capital markets advice andplacement, and business origination.

Products will be developed in those areas that can becommoditized and successful intermediaries will also have toprovide a high level of service to their clients including analyticcapabilities, catastrophe modeling, rating agency advice, marketknowledge, claims services, market security and contractwording.

o Moving Beyond Traditional Re

Traditional reinsurance will always, by definition, be amainstay of the reinsurance intermediary. Being able to demonstratea high level of core competencies and reinsurance market knowledgeremains essential.

In addition, capital market advisory services are an importantarea of growth for intermediaries. Vehicles such as catastrophebonds, sidecars, catastrophe swaps and indexed reinsurance havegrown in use in recent years. These products have expanded theavailable solutions for clients and can provide tailored andcost-efficient risk financing.

Reinsurance intermediaries are well placed to assist in thisarea as they have the deep knowledge of the insurance marketplaceand of the strategic and financial needs of individualcompanies.

o Client-Focus: New Business Tools

Business origination is another service that intermediaries canoffer in addition to traditional reinsurance. Client companies havebroader goals than shedding unwanted risk to third parties. Theylook to not just mitigate loss but also meet strategic goals suchas increasing market share, expanding into new product lines anddeveloping underwriting expertise.

Intermediaries are well positioned to offer strategic advice inspecialty solutions–and to offer the value-added service ofgenerating program business for their clients.

o Tailored Compensation

In this product and service environment, standard brokerage mayno longer be the right measure of compensation.

Brokers will respond by tailoring compensation to the uniqueneeds of the client, based on the expense required to service thebusiness and the value created.

Clients will want to know if they are getting the right servicefor the right price. In response, intermediaries will need toclearly define the services they will provide and more accuratelydetermine the compensation that is needed to support delivery ofthose services.

An alternative to standard brokerage is a fee-for-servicearrangement. Instead of basing compensation on the amount ofreinsurance placed, intermediaries can establish pricing based onactual time and expense required to service the account, plus aprovision for profit.

This approach of defining the services and costing them outprovides both clients and the reinsurance markets a moretransparent and efficient compensation arrangement.

Reinsurance intermediaries who respond to the changingenvironment will be able to provide additional advantages to theirclients. Customers will benefit from a broader array of riskmanagement tools and financing to address their strategic andfinancial goals. They will be able to access sophisticated advisoryservices, such as capital management strategies, enterprise riskmanagement consulting and rating agency support.

Both clients and the reinsurance markets will benefit fromcompensation transparency and remuneration flexibility.

The role of the reinsurance intermediary is changing. Successfulintermediaries will be those who recognize the new environment andrespond appropriately.